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Peter Adriaens is professor of environmental engineering and finance and director of the Smart Infrastructure Finance Center at the University of Michigan.

Students in Detroit still can’t get a drink from a water fountain. It’s been two weeks since the superintendent turned the taps off due to copper and lead contamination.

Another day, another failure of basic infrastructure. And another socio-economically disadvantaged and vulnerable population failed by government.

While the blame game has just started on whether the water utility or the supply lines to the schools are at fault, the core problem is that the way we are financing public infrastructure is stuck in the 20th century.

It’s time to start thinking outside the box of traditional bonds and consider the much broader suite of options available under 21st century private financing mechanisms. We’re exploring this at the Center for Smart Infrastructure Finance at the University of Michigan, and it would behoove government entities like Detroit Public Schools to do the same.

Public financing of social infrastructure such as our schools and roads has been functionally bankrupt for decades. Functionally bankrupt because the public financing model is directly tied to economic inequality, which has only been rising in the last few decades. The school funding debate and the cost of poverty are nothing new.

For Detroit in 1994, the traditional property tax funding model was shifted to state taxes, with funding tied to enrollment. The district has to service 97 schools, in various states of disrepair, and enrollment has been dropping.

This year the district has $5 million available for school maintenance. It needs 100 times that. This summer, it released a report that listed $500 million in repair needs. Fixing the plumbing alone would cost nearly $30 million.

Theoretically, municipal bonds could be issued. If only the district weren’t all but bankrupt, save for an accounting maneuver in 2016 that allowed it to ‘shed its debt’ in a shell company. And as of 2017, existing Detroit City School District bond refinancing was downgraded—made more expensive—even with the state’s aid to help service the bonds.

Despite the accounting changes and business restructuring, this is not a sustainable model.

Not for Detroit schools or other social infrastructure. Public finance continues to kick the can down the road. Disruptive solutions lie in data-driven financing and business models which have taken hold in other sectors in recent years.

Securitized debt, fractional financing, and technological innovations such as digital finance and fintech render investment more agile, forward looking and decision-centric. Fintech refers to technologies that can computationally resolve inefficiencies in investment models by the use of crypto-currencies or smart contracts that execute automatically based on performance.

These concepts are applied for smart billing and leak detection in city water systems to predict water use and develop demand-driven pricing models. In the energy sector, blockchain is used for more efficient accounting of clean energy production and sales. And in transportation, real-time use metrics are informing road financing.

Investment in infrastructure is starting to become driven by its performance.

The smart infrastructure finance models we’re exploring at U-M take advantage of today’s internet of things—ubiquitous sensors that are redefining what we know about how infrastructure is used, and, in turn, how it can be financed.

Imagine infrastructure as having two sets of values or attributes. The first is its functional use. In the case of water fountains, this is water delivery. In the case of roads, it is delivering a means of transportation. The second is the information content of the infrastructure. This could be the number of bottles filled or amount of water dispensed at a water fountain, or the traffic volume, truck weight, or surface deterioration of a road.

That data has value to third parties for various applications: An increase of water dispensed may be related to a reduction in sugary drinks, or health metrics such as obesity. Economists already use this type of model to infer insurance risk or compute lifetime earning potential. Road traffic data have value to hedge funds as a leading indicator for economic activity, which helps them make investment decisions, or can potentially predict where potholes might develop.

Detroit Public Schools could, for example, adopt the smart infrastructure finance approach of the master trust, which would bundle properties for investors and conceivably turn a profit. The investment comes from selling data, or securitized revenue streams from smart infrastructure, into insurance, bond and derivatives markets.

Here’s how that would work: The 97 buildings of the Detroit School District are located in areas with varying property tax valuations, business activity, demographics, and educational performance. In addition, the upgrades needed to the school buildings vary widely. A typical public finance approach would be to address the greatest needs first, much like prioritizing the most vulnerable and most widely used bridges. However, from an investment risk-and-return perspective, one would never do that.

Using a Master Trust, properties can be bundled in groups, or series, of variable risk. This risk is tied to variable interest rates and credit ratings. For example, an A-rated securitized debt tranche can be issued for a series comprised of a set of buildings in areas of higher value and with lower upgrade costs. A higher-risk BB-rated tranche comprises a series requiring, for example, greater investments in upgrades or less tax revenue. Investors would buy these tranches, and the interest would be paid from millages or state aid. The district could use the investment funds to upgrade school infrastructure, including the water system. These upgrades would include sensors for monitoring use and water quality, as they are important for the impact metrics.

Over time, the measured performance data of the water upgrades and their impact metrics will start indicating trends—like correlations between water use, health metrics and student absence, or traffic volume and incidence of road fractures. The district could sell the data to third parties such as mortgage companies or property investors. Positive performance metrics are valued by the market, and will pay a premium on the investment, much like stocks increasing in value if a company does well. Resulting investor demand will result in more series being created and increasing funding will become available for upgrades.

Financial innovations like these could help close the infrastructure finance gap. I view this as an opportunity to level the playing field and rethink how we finance public infrastructure for the next generation.

Bridge welcomes guest columns from a diverse range of people on issues relating to Michigan and its future. The views and assertions of these writers do not necessarily reflect those of Bridge or The Center for Michigan.

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Comments

This is the same level of braininess that was touted in the Economist newspaper 10-15 years ago in their cover to cover praise of financial derivatives. These bonds and tranches were reported to be insurance against risk. Barney Frank noted that they freed up a lot of money that could be invested. So many wonderful attributes! I can scarcely stop myself from chocking up from gratitude to the Nobel laureates for paving the way.

The truth on the ground is that one has to pay for this lolly, that the schools and the city of Detroit are dying and soon the need for all of these upgrades will approach zero; but never completely zero.
It will be an asymptotic curve. How's that for braininess?

Government has become a criminal enterprise. The majority of tax dollars collected are squandered for the benefit of the connected few. One example is former governor Grandholms husband being put in charge of state gambling commission. What a revolting development. Until we enforce the laws on those who make the laws we can go nowhere.

None of it matters. Until we get our heads out of our butts and realize that problems will never be solved by taxing the other guy, nothing will get fixed or built.
We're stuck with two groups of idiotic politicians that are far more concerned with getting the job than doing it right. And hate it all you want, the media has joined them rather than exposed them. As long as we embrace the concept of graduated taxation, we're cooked. The government is the ultimate service sector industry that has no competition. There is nothing wrong with using transactional taxation to fund the government. It would not be "regressive" except in one factor. Those in government would no longer be able to use a tax code to pander us. They would have to act in a responsible manner rather than demonize those that don't vote for "them". Everybody in the society would have a stake. Yet these sound policies will never be embraced. "They" want to keep us as believing an adversarial government and press is "good".
So to put it in simple terms, nationwide sales taxes, redistributed proportionally to how and where they are collected with limited variation depending upon a national "need". End the silly and destructive 50 different state tax programs within reason. Make government a building enterprise instead of what it is now, confrontational and punitive.

It'll never happen, we'll elect socialists first because they make empty promises.

This makes no sense whatsoever. Districts can already borrow at very low rates for building and infrastructure improvements. The issue is that a specific millage has to be passed to pay for the bonds, and adding to the 89 mills Detroiters already pay would likely not be supported. It isn't a lack of capital funding; it is that someone has to pay the bills, and that requires taxes, which people have not heretofore supported

This is a very timely and interesting discussion as it relates to the state of infrastructure around the US. I would like to learn more about the economic approach you propose. I would also like to comment that too often our discussions on funding leave out the human component around whom the funding discussion revolves. I recently saw a statistic from the National Science Foundation that 15% of their funding goes towards training grants/fellowships that only apply to US citizens or permanent residents. I wonder what universities would look like if the 85% of other types of grants, on the other hand, had that requirement. Would our universities and colleagues invest more in local K-12 and communities if the pool of incoming funded researchers had to come from within the US? I wonder how many of our college classrooms reflect the demographic make up of the cities and states in which we operate. And I wonder if conversations on raising the socioeconomic status of neighborhoods around our campuses/cities would not be a better measure of our impact as educators versus the impact factor of the journals in which we publish. What can we learn from Michigan as a place that lost a once state of the art industry? Is this the future for other states as something like AI replaces today's jobs? Who are our most vulnerable to this type of change? Who is complicit in the underdevelopment of our communities? And how can we hold entities and each other accountable for the failed systems left behind?

Has anyone else recognized the tendency to float 20 or 30 year bond issues to fund furnishings, carpet, technology, and other well meant improvements and needs in our schools. These improvements are predictably worn out/obsolete well short of being paid for. Then it becomes necessary to go to the voters for another "loan" for replacements! This is a vicious cycle that eventually leads to deepening long term dept.

It's interesting to me that 9 people could comment on this article as if they actually understood what the author was proposing. In my years of working for MSU, one of my major jobs was helping academics to write about their research in language that the average educated layperson could comprehend. This gentleman needs that kind of help! Such a conglomeration of techno-babble I have not read since my editing days. He may have some very interesting ideas to propose. Please write it in language that the average college educated person can understand!